Cry for Argentina

Abstract

For many years prior to 1991 Argentina had experienced very rapid inflation. This undermined competitiveness and led to frequent devaluations. The cycle of inflation, devaluation and more inflation was politically unpopular and the breaking of this cycle became a political priority. The government attempted to do this by pegging the value of the peso to the US dollar and setting up a currency board both to increase the credibility of the peg and to constrain monetary policy and therefore fiscal policy. When shocks occurred, such as the Mexican crisis in 1994, Argentina could therefore no longer respond by changing its exchange rate. What happened instead was that the economy experienced recession and rising unemployment. The basic lesson of Argentina's experience is hardly novel: it is impossible to sustain a disequilibrium exchange rate over a protracted period of time. The costs of trying to do so simply became too high in both economic and political terms, making exchange rate realignment inevitable. For this reason, one should not cry for the demise of Argentina's currency peg.